Why should lenders care about building a well-managed Collections function?
Over the past few years, 2OS has expanded our Collections practice to include large banks, credit card issues, and fintechs both in the US and abroad. Since the fintech sector, as well as their customer base, has grown tremendously, there is an increasing need to focus on default management, especially with delinquencies on the rise.
The increase in delinquencies across the industry requires lenders to improve loss mitigation strategies through:
(1) Better risk prediction models,
(2) Contact strategies, and
(3) Forbearance tools.
But there’s an equally important challenge to do so in a well-managed way, since debt collections are full of challenging customer experiences, operations and compliance risks, and high interest from banking regulators. We’ll highlight key areas where lenders need to be in line with regulatory requirements, investor sentiment, and customer expectations.
Being effective at debt collections is difficult, especially in worsening economic environments. Customers don’t want to be behind on their bills but find themselves in financial distress for a variety of reasons. Understanding a customer’s ability and willingness to pay, as well as creating solutions that fit that customer’s capacity, is vital for any lender in their attempts to minimize their credit losses.
We’ll first define a framework for the root causes of complexity within Collections (along with some examples) and suggest important first steps to make Collections a more well-managed part of the lending lifecycle.
What are the root causes of complexity in Collections?
There are many different flavors of complexity. We focus on four of them here:
Inherently Complex Business Functions
Many of the highest profile processes within Collections are maddeningly complex. Complexity scales with the size of the business, but there are some processes that have table stakes (i.e., are fundamentally required) that have high complexity regardless of the size of the business. These include:
(1) Credit bureau reporting and credit bureau disputes: the right data needs to be attached to the right consumer and needs to be sent to the bureaus.
(2) Bankruptcies: there are 90 US bankruptcy courts that work with consumers who seek bankruptcy protection, which means that lenders have many different processes and steps to follow, otherwise they could end up on the bad side of a bankruptcy judge or trustee.
(3) Estates: the death of loved one is hard, and managing their financial accounts isn’t the priority for many families; lenders should show compassion to resolve this in a well-managed way.
(4) Agent incentives: incentive plans that aren’t monitored or carefully thought out might lead to unintended consequences.
Working with Third Parties to Deliver Outcomes
Outsourcing work is often inevitable, because it becomes impractical (or, at the very least, suboptimal) for you to do everything yourself. However, managing third parties is full of risk, which is multiplied due to the function that it’s being outsourced (i.e., Collections). These risks include:
(1) Litigation: suing customers to get a resolution for unpaid debt is a very effective tool, but you need licensed attorneys, which could involve dozens of third parties and could even introduce “fourth party risk” if your suppliers are managing suppliers.
(2) Repossessions: secured lending means you need to have a means of liquidating an asset, and you need to find the right repo partners with the right controls in place.
(3) Debt sales: you might think you can just “sell it and forget it,” but there are many post-sale exceptions processes, like buybacks, bankruptcy-related headaches, and media requirements that you need to think about.
Complex Regulations Creating Executional Challenges
Laws and regulations are made with good intentions but might not be written or enforced by people who understand the second order impacts of their requirements. These are examples of some regulations that create complexity and risks for the lender:
(1) Regulation F: originally published by the Consumer Financial Protection Bureau (CFPB) in 2020 to clarify and modernize Fair Debt Collection Practices Act (FDCPA) regulations that apply to debt collectors; it places additional restrictions on outbound contacts (i.e., phone calls and email), which means lenders must be more thoughtful in their outreach strategy.
(2) Telephone Consumer Protection Act (TCPA): this is a 1991 law that places restrictions on the use of fax machines and auto-dialers, which is very different from the current technology of today; unfortunately, politicians and regulators don’t want to associate with new legislation that seemingly removes restrictions from “robocalls.”
(3) Spamhaus: this is a not-for-profit company founded in 1998 to track and stop email spammers but can catch and shut out legitimate businesses.
Operational breakdowns create reputation risk, which can hurt your brand, primarily based on the sum of the sentiment of the individual customer impacts. Being delinquent has an emotional impact on customers, which can make them more likely to complain about breakdowns or gaps to reports, the CFPB, attorney general offices, or their political representatives. A rise in delinquencies is also positively correlated to a rise in volume of these types of complaints. You want to address possible future breakdowns BEFORE you’re in the middle of a period of high delinquencies.
Now that I know about. the complexities of building a well-managed Collections function… what can I do about them?
(1) Leverage trustworthy suppliers, like those who support large banks, for the more complex functions;
(2) Invest heavily in monitoring (e.g., roll rates, liquidation curves, etc.); and
(3) Hire a dedicated compliance advisor, like 2OS, for Collections, which is essential to preventing trouble in the future.